Capital Gains, Carried Interest, and Ordinary Income

Most of our family’s income comes in the form of capital gains. And most of that comes in the form of carried interest on capital gains. Carried interest means the share of the profits that the managers of VC funds get (and PE funds and Hedge funds too).

For many years, there have been attempts to tax carried interest as ordinary income and those efforts have been fought tenaciously and successfully by the VC, PE, and Hedge Fund industries.

As far back as 2007, before USV had paid any carried interest to me, I wrote on this blog that I did not believe that carried interest deserved capital gains treatment and that, in my view, it was a fee and should be taxed as ordinary income.

I re-asserted that view in 2010, just as USV started to pay carry to me and my partners. My partner Albert also stated his views on the topic that same year.

But after thinking long and hard about this topic over the years, I have come to a slightly different and simpler perspective, one that I wrote about on labor day last year.

I think it would be better policy to lower the income tax rate and raise the capital gains rate to something like 20% so that all income is taxed equally no matter how it is achieved and so they the net impact on revenues is neutral.

If we taxed all income at the same rate, regardless of how it was earned, then we would not need to worry about the carried interest loophole and all other loopholes. We would have a simpler and fairer tax code.

I have read that Yellen and Biden are thinking of making some changes to the tax code to increase capital gains rates. I am fine with that. But I think they ought to lower rates on ordinary income at the same time. Get everyone on the same rate. That’s the winning move in my view.